The Stockman Chronicle Jude Wanniski December 3, 1981

Executive Summary: David Stockman, once a supply-sider, had become a powerful opponent of supply-side ideas at the Cabinet level long before the public revelations of his Atlantic Monthly interview. At OMB, he fell back on ideas embedded in him in his pre-supply-side days, ideas reflected in William Simon's A Time for Truth and Stockman's 1975 essay, "The Social Pork Barrel." The Stockman reversion was hastened by his hiring of Lawrence Kudlow as his chief economist, Kudlow having served Simon in 1980 in drafting an economic agenda for the GOP counter to that actually adopted. Alan Greenspan, who had assisted in engineering the 1974-75 recession with Simon, participated again with Stockman in arranging the current slide. Stockman miscalculated, in his economic strategy and on the timing of his interview, believing he would defeat the supply-siders at Treasury with his frightening budget projections. Paul Craig Roberts, who had been losing skirmishes all year, won the big one.

The Stockman Chronicle

Once upon a time, David Stockman was a supply-sider. Some day he may again be one. But at the moment he is an announced, certified opponent of the supply-side agenda and he is in one of the most powerful posts of the Reagan administration. He may no longer be the "Deputy President" as he had envisioned the job under Ronald Reagan long before it was offered him. But in one sense, he may turn out to be just as formidable an opponent of his old allies, now that his Atlantic Monthly interview has completed the break. That is, where he could not quite be trusted by the Old Guard as long as he maintained his nominal ties to the Supply-Side "cosa nostra," it is now clear to all combatants that he has openly cast his lot with the Old Guard. Richard Reeves, the political writer, calls Stockman a "hero of the left" in his syndicated column of November 18. But that is only because Reeves observes the political world from the left. Stockman is also every bit as much the new hero of the elitist right, in that he can represent both these traditional opponents of change via a Reagan Revolution. Those in both parties who opposed the avant garde elements of the Reagan candidacy in 1980, chiefly because they feared change of any kind, now have a vested interest in Stockman's rehabilitation. The enormous deficits that are emerging in the recession will be offered as vindication of Stockman's apostasy, while he, instead of dreading them, can wish them higher, secure in the knowledge that his new allies will use them as weapons against the Supply Side.

Still and all, the supply-siders view the net effect as a plus. Even though Stockman can be used more effectively now that he is out in the open, the supply-siders confessed to feeling an enormous relief in not having to carry the burden he had placed on them, particularly on Jack Kemp. In retrospect, Stockman's defection began in December 1980, when he had secured the Cabinet post through the efforts of Kemp and the other supply-siders, the only Cabinet slot the supply-siders could manage. For a solid year, roughly from Thanksgiving to Thanksgiving, Kemp's effectiveness in advancing the economic program that had elected Ronald Reagan was blunted by Stockman's determination to pursue his own agenda. As the Atlantic interview finally made clear even to Kemp, Stockman used Kemp's affection for him to neutralize Kemp in the high-stakes power struggle over economic policy-making:

"As long as Jack is happy with what's happening," Stockman said, "it's hard for the [supply-side] network to mobilize itself with a shrill voice. Jack's satisfied, although we're sort of on the edge of thin ice with him."

During his unsuccessful bid for a seat in the Reagan Cabinet, former Treasury Secretary William Simon had told a Heritage Foundation gathering that the Treasury post in the Reagan administration would be "in many ways even more important than the Presidency." It was the post Simon wanted again, for the same reason that Stockman wanted OMB. Their own private agenda for America was and is exactly the same, the elimination of the "welfare state" and its costly "free goods," as Simon calls them, or the "social pork barrel" as Stockman puts it. Ronald Reagan, of course, did not receive a mandate for any such explicit undertaking. Had he tried to get such a mandate, he would have lost, not because the public prefers a pork barrel to economic growth, but that it correctly perceives that welfare and pork are symptoms of stagnation and are not to be worried about.

Simon, who with Alan Greenspan at the CEA presided over the deepest recession of our time in 1974-75. could write in A Time for Truth:

It was gratifying that I had succeeded in some measure in taking my case to the people and that President Ford was able to rely on an aroused public to veto forty-five spending bills, sustaining thirty-eight of them. This was, I should add, President Ford's most significant political achievement, although it is rarely described as such. He is usually praised for unifying America after Watergate. . . .But in my view, his most important contribution to the well-being of the nation lies in that barrage of vetoes, bravely executed in the face of immense hostility. Even so, the budget deficit soared to $66 billion, the highest in peacetime history.

As a Wall Street Journal editorial writer, I had met Simon in the spring of 1974, while he was Treasury Undersecretary awaiting appointment by Nixon to succeed George Shultz as Secretary. I urged him to consider the possibility that the economy was in a terrible mess because of Shultz's one great victory, his floating of the dollar in the spring of 1973. I repeatedly urged him to ask Arthur Laffer, then a Treasury consultant, for briefings on international money and exchange rates, and implored him to consider that $10 billion tax cut that Mundell and Laffer said was needed in 1974 to avert a recession and $60 billion deficit in 1975. But his eyes glazed over, and his repeated promises to find time for Lafferian briefings evaporated into WIN buttons, tax boosts, budget cuts and spending vetoes and the Simon-Greenspan-Ford recession of the period.1

David Stockman, who was 28 years old at the time the 1974-75 economic slide began, observed it from his vantage point as executive director of the House Republican Conference, then chaired by Rep. John Anderson of Illinois. Even then we can feel his anger at the perceived "greed" of the "special interests1' as they jostled at the public trough; He wrote "The Social Pork Barrel" for Irving Kristol's Public Interest quarterly during the recession and it appeared in the Spring 1975 issue. The steady climb in federal spending, over and above official budgetary forecasts, could not be explained by inflation alone, he observed:

Since no major new spending programs have been adopted in the last few years, it can only be concluded that Congress abhors prospective budget surpluses, preferring to nickel and dime them into oblivion long before they appear. . . .

If the programs which comprise and the rhetoric which surrounds the social pork barrel are liberal in paternity, this distinction usually fades with the passage of time. Indeed, the political maintenance capabilities of the system are so strong that all except the most extreme and idiosyncratic conservatives are eventually brought into the consensus. . . .

By the time the program has gotten into operation and becomes visible at the local level, nearly all of the potential "opposition" can be found — along with their Democratic counterparts — enthusiastically issuing press releases announcing grants and turning up for each cornerstone-laying or ribbon-cutting ceremony marking the kickoff of a new district project. Should some bespectacled budget analyst in the Executive Office Building propose that the program be reduced or eliminated, the retreat will be shown to have come full circle, as a chorus of reputedly conservative Congressmen gravely intone: "I'm four-square for cutting the swollen federal budget, but this is the wrong program at the wrong time in the wrong place."

Ironically, in the same issue of the magazine there appeared my earliest exposition of what I later came to call "Supply-Side economics." It was entitled "The Mundell-Laffer Hypothesis—A New View of the World Economy." The article described the breakdown of the international monetary system and the floating of currencies away from gold as the heart of the global economic malaise. But in a footnote I addressed the fiscal problem and its budgetary symptoms in a verbal description of what three years later became graphically known as the "Laffer Curve:"

Taxes should be cut and government spending maintained through deficit financing only when a special condition exists, a condition Mundell and Laffer say exists now. "There are always two tax rates that produce the same dollar revenues," says Laffer. "For example, when taxes are zero, revenues are zero. When taxes are 100 percent, there is no production and revenues are also zero. In between these extremes there is one tax rate that maximizes government revenues.". . . .Even if a bigger deficit emerges, sufficient tax revenues will be recovered to pay the interest on the government bonds issued to finance the deficit. Thus, future taxes would not have to be raised and there would be no subtraction from future output. Tax cuts, therefore, can actually provide a means for servicing the public debt.

A year later, in January 1976, I met Kemp, who had become intrigued by tax-cutting theories; Paul Craig Roberts, now Assistant Treasury Secretary for Economic Policy, was then his staff economist. I did not meet Stockman until December 1977, at an early "supply-side" party in Washington attended by Kemp, Laffer, Roberts and several others, including Bruce Bartlett, who had succeeded Roberts as Kemp's staff economist and is now deputy director of the Joint Economic Committee of Congress. In the wake of the Atlantic Monthly revelations, Bartlett recalled those earlier days:

I remember clearly when Stockman became a Member of Congress in January 1977. He previously had been on the staff of Congressman John B. Anderson of Illinois and I, like most others, expected that he had adopted his boss's liberal views. I was working for Congressman Jack Kemp at the time, and we were very pleasantly surprised when he became our strongest ally in Congress, in our early efforts to cut taxes. Dave, in fact, became almost a member of Kemp's staff, applying supply-side principles in a number of different areas including energy and welfare. By way of example, let me quote to you from Stockman's testimony before the Senate Finance Committee in July 1978:

"Will the large tax cuts in Kemp-Roth result in huge budget deficits, hyperinflation and worsened monetary instability, as many economists are now charging?. ...

"Now, I would suggest. . . .that these charges are based on a total misunderstanding of what Kemp-Roth is all about. We are not merely advocating a simple election-year gimmick. Instead, we view this measure as just one policy step in a whole new fiscal policy program based on the supply side of the economy; based on the idea of getting more labor, capital, innovation, risk-taking and productivity into the economy by removing Government barriers and deterrents, the most important of which. . .is the rapidly rising marginal tax rates. . . ."

In this period, it is no exaggeration to say that Stockman became Kemp's chief lieutenant in a series of legislative skirmishes against the Carter White House, struggling unsuccessfully for Kemp-Roth and against energy regulation and imposition of the windfall-profits tax. In 1979, Stockman was among a small circle of friends who discussed a potential Kemp presidential candidacy in 1980, plans that ended when Kemp agreed to support the Reagan candidacy as Reagan embraced the Kemp agenda for economic growth. Stockman subsequently surprised Kemp and the other supply-siders by announcing that he had committed himself to the candidancy of John Connally. His rationale, to me, was that Reagan couldn't win against Connally, the clear favorite of corporate America, and that only Big John would have the forcefulness to dominate Congress in an assault on spending and regulation. When Connally's candidacy crumbled early in the season, Stockman switched to George Bush, with no other rationale except a belief that Bush would win. His support for Reagan came after the fact, an item hardly noted at the time because his junior status gave little weight to his endorsements anyway.

To the supply-siders, it seemed more important at the time that Stockman had courted and made connections with William Greider, the Sunday Outlook editor of The Washington Post, who opened doors and ears at the Post that had previously been closed to the supply-siders. Stockman boasted of his success, which resulted in op-ed space being made available to him at will. And the editorials that had previously ridiculed supply-side seemed to lose their bite, although this followed Reagan's strong showings in the primaries.

Supply-siders dominated the design of the Republican Platform, with Kemp, Roth and Stockman chairing the three key subcommittees. Stockman assisted in drafting the "gold plank," and while he did meet several of the key Reagan lieutenants, he did not meet Reagan until he imitated John Anderson in mock debate with Reagan, in late August. It had been my idea, passed by Kemp and his staff to the Reagan high command, that Stockman's counsel would be invaluable; the move also served the supply-siders' need to have their views represented in the briefings. After the New Hampshire primary and the sacking of John Sears, supply-siders had lost their assured access to the high command. Stockman would regain it. On the other hand, we were disappointed that he was not providing supply-side inputs at the briefings, but he felt that as an imitation John Anderson or Jimmy Carter that was not his role. In any case, he endeared himself to the Reagans and the Reagan high command.

It's entirely possible he would have been named OMB director without the support of the supply-siders. But in that case, it would have been extremely difficult for the high command to deny Kemp some other Cabinet selection, Lewis Lehrman, for example, at Treasury or the CEA. As it was, the supply-side reward went to Stockman, who, we soon began to suspect, seemed to be subtly undermining attempts to have Lehrman placed in a subcabinet post. At least, Lehrman was shut out completely, and there is no evidence that Stockman lifted a finger to prevent it. With unassertive or inexperienced appointees at Treasury, CEA and the White House economic posts, Stockman was in full command of the economic agenda.

His abandonment of the supply-siders began immediately. In early December, when his appointment was secure but not yet announced, he asked me to guide him on a tour of Wall Street; he wanted to meet the movers and shakers, he said. I subsequently learned that he simultaneously asked Richard Whalen, an Arthur Burns' protege, to do the same, which meant that Whalen and I awkwardly made contact to divide the schedule. The day included meetings with Henry Kaufman at Saloman Brothers, Lawrence Kudlow at Bear Stearns, Alan Greenspan (who Stockman had already met with) and a supply-side dinner celebration of the Stockman appointment at the Century Club, hosted by Lehrman and attended by several supply-side activists. Columnists Rowland Evans and Robert Novak reported in their syndicated column of December 26:

But after making the rounds downtown December 18, Stockman ran into static when he and Kemp dined in New York that night with some leading exponents of supply-side (pro tax cut) economics.

Some of the more doctrinaire supply-siders complained that Stockman was so intent on budget cuts that tax reduction was being sidetracked. The truth is, however, that even Kemp has dropped earlier misgivings about massive budget reduction on grounds that his tax plan cannot be credible without it.

The most far-reaching consequence of the Wall Street tour turned out to be Stockman's meeting with the Bear Stearns' economist, Larry Kudlow, who he subsequently hired as OMB's chief economist. Kudlow, a smooth-as-silk 30-year-old economic gunslinger, for three years had maneuvered among monetarists, supply-siders and budget-balancers, placing modest political bets all around, including a few chips on California Gov. Jerry Brown (who delivered at least one Kudlow speech during the Democratic primaries). Kudlow had persuaded Kemp that he was a pro-gold supply-sider, which is why Stockman asked to meet him. But in the early summer of 1980, going into the GOP convention, Kudlow figured the smart money would be on William Simon, who might get the VP nod, but who would certainly get a powerful Cabinet post in a Reagan presidency. Hence Kudlow's Bear Stearns' economic letter of July 15, 1980, "The Republican Party is Making a Mistake."

The Republican Party is lining up four square behind tax rate cuts as the economic panacea of the 1980s. Up to now the party has made no effort to connect these tax rate proposals to other financial policy issues such as Federal spending, deficits and debt management. Nor has there been any effort to articulate clearly a monetary policy strategy. Nor hardly a word about inflation. Instead, rather than a comprehensive, balanced and analytically sound program, the GOP appears headed toward an economic policy which is one-dimensional, simplistic and without any apparent cohesion or depth....

No one understands the psychological nature of the debt management problem better than a former manager of the nation's debt, William E. Simon. . . .He understands that after 15 years of expanding inflationary pressures, there will be no quick fixes to solve the problem. . The former Treasury Secretary has developed a mature and comprehensive future agenda for economic policy in the 1980s.

There follows a five-point program that Simon presented in testimony to the Republican Platform Committee in early June, testimony written by Kudlow. The budget must be balanced over a business cycle. Spending must be reduced as a percentage of GNP. Tax rates must be cut even though they cause deficits in the short run and contribute to inflationary psychology. Growth in the money supply must be limited; "monetary policy remains very much a creature of budgetary policy." And, reduction of government regulation.

The Kudlow letter concludes:

The tax cutting issue may have peaked already. When the public sees a sticky double-digit inflation rate this summer, demands will resurface for a predictable and disciplined fiscal approach. Governor Reagan's platform does not position him adequately to deal with voter demands for a predictable and disciplined fiscal approach. The current emphasis on cutting taxes is therefore overstated and politically dangerous. Moreover, from the standpoint of sound economic policy in the 1980s, the emphasis on tax reduction is incorrect.

If Governor Reagan is to establish public confidence as an economic policymaker, he must adopt a more balanced and comprehensive approach. He must emphasize a multi-faceted program along the lines of the Simon future agenda. The Simon program has greater depth and maturity. The Simon program will foster the sense of confidence and competence so necessary for electoral success. Without such an approach the Reagan lead of today will quickly disappear this fall. The country is looking for new leadership, and it seems that voters might be willing to turn to the Republican Party. But the GOP must earn this support by telling an honest and complete story. Up to now the story seems a bit too transparent, a bit too political, and the voters are being sold a little too short. In our own mind the Republicans are making a big mistake.

Stockman barely made it into 1981 with a breath of supply-side left in him. Kemp and others got him sufficiently pumped up for testimony before the Senate Governmental Affairs Committee on January 8, and his message began clearly: "If we fail to cut taxes, we have no chance, no hope, of bringing the budget into balance. The tax burden today is so debilitating. . .that without a growing economy we can't afford to balance the budget."

But then the slide began, with Kudlow patter, Stockman saying that the "single problem today we have to address" is an "utter lack of confidence" that the federal government can control its budget and the Federal Reserve Board can control the money supply sufficiently to bring down the inflation rate. And then, ominously, Stockman's observation that the "windfall-profits tax" on crude oil production "isn't sound energy policy," but that it is "a pretty prodigious producer of revenue" and on that count should not be removed, as Stockman had written into the GOP platform as chairman of its energy subcommittee. Within weeks he was calling for the end of the oil depletion allowance as another source of revenue. By Inauguration Day the Dr. Kudlow and Mr. Simon metamorphosis was complete. Alan Greenspan became Stockman's most welcome guest at OMB, Kudlow his closest confidante, with Simon in the wings as Kudlow's catspaw. Few men in history have the privilege of helping engineer two severe recessions. Hoover only had one Depression to his credit; Green-span and Simon managed their second the hard way, outside the administration.

It was bad enough that Stockman could persuade the President to push the tax cut from 10 percent in 1981 to 5 percent and the 1% percent, for "budgetary reasons," as Kudlow explained. The greatest loss to the economy was the failure to represent the supply-side position on gold, which left the President without any support in the Cabinet for a hard monetary policy. Indeed, as Stockman came to reflect the views of Greenspan and Simon, he punctured support for the gold option when he found it surfacing in the White House. "In point of fact/' Bruce Bartlett of the Joint Economic Committee noted in his November 19 speech, "the Office of Management and Budget has done more to undermine supply-side economics in the last three months than all the Democrats in Washington put together."

The Stockman Atlantic Monthly "confession" that Kemp-Roth was nothing more than a "Trojan Horse" designed to reduce the top marginal tax rate to 50 percent from 70 percent is, in this light, genuine. The Old Guard, represented by Greenspan, Simon, Shultz, Burns, etc., never believed in Kemp-Roth as a policy instrument to expand the productive base and tax base; they swallowed it because the President believed in it and won a mandate for it and because they could trade on it to get the top rates down. They are all demand-siders and as a result understand across-the-board tax reduction with the "trickle-down" rationale. The concept can only exist in a demand framework, and by now Stockman is wholly in that framework.

Stockman formally divorced himself from supply-siders in the Greider article as part of a calculated risk. While he told President Reagan that he had been "sandbagged" by Greider (without an excuse he probably would have been fired), he not only knew the article was on the way, but also was permitted to make minor changes before the magazine went to press.

The risk was this: For months he had been engaged in warfare with the supply-siders in Treasury and on Capitol Hill. In mid-October, he certainly acted as if he had won a broader austerity plan, including deeper spending cuts and "revenue enhancement" (Kudlow's term, borrowed from Simon's Undersecretary Ed Yeo). He had Senators Dole and Domenici in his corner, waving his budget projections like a scarecrow. Donald Regan seemed about ready to sign on and so then would the President. The Atlantic Monthly would publish at just about the right time, to formally inter the supply-siders in Stockman's moment of victory.

But he did not count on losing, as Donald Regan and Ronald Reagan stood firm. Regan on October 31 announced that the administration would drop its pledge of a balanced budget in 1984 rather than chase it with increased taxes. By then it was too late to retrieve the magazine article, which surfaced 10 days later. Knowing he had miscalculated, Stockman pressed forward even after palpable defeat, urging friendly senators to ignore the red lights flashing from the White House. He sought a meeting with Kemp as well, waving the deficit projections, pleading for support for deep budget cuts and tax increases. At that late hour, Stockman had not lost his effectiveness; after the meeting, Kemp called around announcing that "Stockman isn't our enemy."

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If there is anyone in all of this who deserves a supply-side medal with oak-leaf cluster it is Craig Roberts, who throughout the year dueled Kudlow and who lost almost every skirmish except the last big one. The nature of this bureaucratic duel was unusual in that OMB always seemed to have the advantage over Treasury, the first time in memory that this was the case. Treasury's professional staff is so much broader and deeper than OMB's that it can almost always prevail in the paper wars over economic policy with other agencies, including OMB. But because Treasury all year has been tied in knots at the top, with a demand-side monetarist (Beryl Sprinkel) and a supply-side fiscalist (Norman Ture) serving Donald Regan directly, Roberts and his deputy, Steve Entin, were left almost alone, isolated from Treasury's vast resources during the battles with OMB. Inside observers could see that Kudlow always had Stockman and thus all of OMB behind him, but that Roberts could never count on similar backing from Ture and Sprinkel. The White House, of course, determines the outcomes of these intramural wars, and routinely the winner is the agency that can supply the earliest position paper. These are the victories Treasury is used to winning, but not unless the troops are fired up, and to date they've not been. The saving of Ronald Reagan and the tax cut was a personal victory for Roberts, and it would not surprise too many if he were moved into a White House post that only a month ago Kudlow was eyeing; Martin Anderson may soon be leaving for the Fed. The White House needs a genuine believer, other than the President, to sell the economic program in the coming political year. Murray Weidenbaum can barely manage his way through the Sunday afternoon talk shows and Stockman's value as a Reaganite TV personality has been greatly diminished, perhaps to the vanishing point.

Once upon a time, he was top banana.

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1 The current White House Communications Director David Gergen, Simon's speechwriter in that period, recently recalled for me that Treasury opinion at that time was that the recession was not permitted to run deep enough so as to wring the inflation out of the economy. Ford's chief of staff Donald Rumsfeld reversed the Simon-Greenspan tax-increase policy, but even so, Simon's Treasury Department produced a $50 tax rebate instead of marginal-rate reduction. In January 1977, George Bush advised me that President Ford's mistake was that he did not veto even more spending.